Minimizing an Estate’s Income Taxes

Well, June 9th was Tax Freedom Day in Canada. Let’s face it, as Canadians we hate paying income taxes and we pay more than all but a small handful of countries in the world. A massive industry is built around minimizing taxes for Canadians – they are wonderful folk we call accountants. And while it is always recommended that you seek the counsel of a qualified CPA to assist with your estate’s tax minimization strategies, there are some basics that you should understand before you engage them.

The final tax return for the deceased is what needs to be completed for the year they pass away. Without any tax strategies, there may be a lot of taxes owing, and the estate will need to swallow all of them. Some simple planning can help minimize these taxes, and I will briefly outline 5 of those strategies here:

#1 – Take advantage of spousal rollovers. With a common-law partner or spouse, no capital gains tax will be owing (as it normally would be) if you elect to have all capital property move into your partner’s name upon death, including but not limited to houses, cottages, investments, RRSPs and RRIFs. If this ‘rollover provision’ is not taken advantage of, half of the capital growth would be taxed at the deceased’s marginal tax rate in the year of death. Take advantage of this tax deferral. Taxes will only be owing now when the second spouse sells the property or dies.

#2 – Give assets away while you’re still alive. One way to reduce the amount of taxes owing at death is to spread out the tax bill by selling or gifting property in years prior to death. Remember, the way our marginal tax brackets work, it is better to spread income out over several years rather than pay the maximum 53.5% marginal tax rate for income exceeding $220,000 in Ontario in the year of death. Because capital gains tax (for physical and financial property) can be significant, it may be beneficial to gift some assets that have appreciated significantly before you die – again, to spread out the tax bill in years when taxable income is lower.

#3 – Take advantage of exemptions available to you. If you own more than one residence (say a home and a cottage), you should spend a few minutes determining which one you should deem as your primary residence for tax purposes. The primary residence will have no tax owing on it (regardless of when you sell it, or who it might gift it to) for the years you deem it your primary residence. Because you can only name one property per year as your primary residence, it’s a good idea to name the one that has appreciated the most as your primary residence, and pay the lower capital gains tax bill owing on the other one, upon its sale.

#4 – Give to charity. There are serious tax credits for charitable gifts given upon your death (usually gifted through your will). In fact, if you donate marketable securities – like say, stocks – there will no capital gains inclusion on your tax return. In this case, it actually pays financially to be generous.

#5 – File multiple tax returns. If you can spread your taxable income across more than one tax return (thereby taking advantage of personal tax credits and basic personal exemptions for than once!), then do it. And it’s possible you could qualify for 2 or 3. There is the Final Return, the Return for rights or things, the Return for income from a testamentary trust and a Return for a partner or sole proprietor. Spreading income out across a few different tax returns will protect some of your money from the highest marginal tax rates – always a good thing.

So, yes taxes at death are inevitable. However, by discussing these strategies with your tax professional you might be in a position to protect your Final Return from some taxes owing, and provide your loved ones with a bit more of a financial legacy.

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